As you begin to think about selling your business, excitement about what your life will look like after the sale may be tempered by the reality of a significant capital gain recognition event. One way to manage some portion of the potential income tax consequences of a sale is through philanthropy. Thoughtful charitable planning may provide both meaningful capital gain management and an opportunity to give back to the community that allowed you and your business to thrive. You may make a charitable contribution either before or after the sale of your business. There are advantages and considerations for each.
Contributions After the Sale
The simplest way to make a charitable contribution is to make a donation from the proceeds of the sale. If you contribute cash to a qualifying public charity or a donor-advised fund (“DAF”), you may receive a charitable income tax deduction of up to 60% of your adjusted gross income (“AGI”). To the extent that your donation exceeds 60% of your AGI, you may carry forward the excess deduction for up to five years. For donations of cash to a private foundation, the threshold is lower – 30% of your AGI, subject to the same five-year carryforward.
Charitable Gifts Before the Sale
Instead of waiting until after the sale of your business is complete and donating a portion of the proceeds, you may instead wish to make a charitable gift of an interest in the business prior to the sale. There are two major advantages to donating prior to the sale. First, just like with a donation of post-sale proceeds, you will receive a charitable income tax deduction. Second, you will never have to recognize the gain embedded in the donated business interest. Qualifying charitable organizations are tax-exempt, so when the business sells, the charity will not recognize any gain and will receive 100% of the value of the donated property.
While donating prior to the sale provides the “double benefit” of a charitable income tax deduction and the avoidance of gain recognition, pre-sale planning does entail some additional considerations. The charitable income tax deduction thresholds for gifts of appreciated property held for more than one year – including interests in a business – are lower than those for cash. If you gift an interest in your business to a public charity or a DAF, you may only deduct up to 30% of your AGI (with the same five-year carryforward period). For contributions to a private foundation, the limit is up to 20% of AGI. In addition, the value of a gift of a business interest to a private foundation will be equal to the lesser of the property’s appraised fair market value and its basis, potentially deeply reducing the value of the donation and, by extension, your charitable income tax deduction.
Unlike a share in a publicly traded company, the value of an interest in a closely held business is not readily ascertainable and must be determined by a qualified appraisal by a qualified appraiser. Appraisals may be expensive, and the appraised value of an interest in your business may be lower than you anticipate if, as is common, the appraiser applies discounts for lack of control and marketability.
Timing is critical when it comes to the charitable donation of an interest in a closely held business. Under what is known as the doctrine of anticipatory assignment of income, once there is a binding commitment to sell the business, the gain from the sale will be taxed to the owner, even if they transfer their interest to another prior to close. Consequently, if a business interest is contributed to a charitable organization after the donor has entered into a binding commitment to sell, the donor may still be taxed on the gain even as the proceeds of the sale belong irrevocably to the charitable organization. Charitable donations made during the period prior to a binding commitment to sell will not be affected by the doctrine; however, the exact moment at which a commitment to sell becomes binding may be a gray area. You should consult with your estate planning attorney and tax adviser regarding the timing of any potential charitable gifts of interests in a business.
Finally, entities taxed as S-Corps and partnerships may carry additional tax complications. Charitable gifts of S-Corp stock may create income tax consequences for the charitable organization (an otherwise tax-exempt entity) in the form of unrelated business taxable income (“UBTI”), and a contribution of S-Corp stock to certain types of charitable entities may terminate the company’s S-election. Charitable contributions of partnership interests that are subject to liabilities may result in gain recognition to the donor in the amount of the debt under the bargain sale rules. It is important to discuss the potential income tax implications of donating interests in a closely held business with your tax adviser.
Conclusion
While cash donations after the sale have the advantage of simplicity and a high AGI deduction threshold, they do require you to recognize gain from the sale and make the gift from after-tax proceeds. By contrast, giving before the sale may be more tax-efficient, but involves potentially significant additional complexity. Your Wealthspire advisor and the Family Office Services team are happy to discuss potential gain management strategies and are here to help you before, during, and after the sale of your business.
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This material should not be construed as a recommendation, offer to sell, or solicitation of an offer to buy a particular security or investment strategy. The information provided is for informational purposes only and should not be relied upon for accounting, legal, or tax advice. While the information is deemed reliable, Wealthspire Advisors cannot guarantee its accuracy, completeness, or suitability for any purpose, and makes no warranties with regard to the results to be obtained from its use.
